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The climate policy of an oil producing country –

demand-side versus supply-side policies

By

Taran Fæhn, Cathrine Hagem, Lars Lindholt, Ståle Mæland and Knut Einar Rosendahl,

Statistics Norway

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Main Research Question

• Given a target for domestic contribution to global emissions reductions – what is the optimal combination of reduced fossil fuel consumption and reduced fossil fuel production?.

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MotivationOngoing political debate in Norway – prior to the elections

– The role of petroleum extraction in the Norwegian climate policies

– Parliament’s ambitious, expensive agreement on domestic demand-side

– Why only demand-side? Oil interests against environmental interests

– Debate fuelled substantially by our recent reports and media activity!

Literature:– Demand side carbon leakage of unilateral climate policies

Increased demand abroad Bohm, 1993, Markusen et al. (1993; 1995), Rauscher (1997) and Böhringer et al.

(2010)

– Supply-side carbon leakages Increased supply abroad Harstad (2012) shows that the best policy is simply to buy marginal foreign fossil

fuel deposits and conserve them (inelastic supply on the margin)

– Optimal combinations of supply side versus demand side Hoel (1994), Golombek et al. (1995) Demand side versus supply side – Norway, Hagem (1994).

Our contributions

• Update previous numerical estimates

• Emission intensities in extraction can vary among countries

• Imperfect competition

• Empirical cost assessments of marginal cuts in Norwegian oil production

• A survey of the fossil fuel market elasticity estimates from the literature

Model: Domestic objective function

• Maximise welfare (W), subject to the global climate policy target :

• First order cond.:

i i

o c g i i i i iy ,x i o,c,g i o,c,g

0

Max W B(y , y , y ) c (x ) P ( ) (y x )

s.t.

E E A,

i

i i

y i i i i

y x

B P P c (x )

E E

A

Model: The energy market

• Three fossil fuel markets (oil, coal and gas)

• Static model – less suitable for existing extraction fields (Hotelling, green paradox) – suitable for new developments, including enhanced oil recovery (EOR) investments

• Global emissions, E, including extraction emissions:

• Fossil fuel market equilibria:– Oil market: net Home import = fringe supply abroad + OPEC (dominant producer) - demand

abroad

– Gas and coal markets: , i = c, g

i i i ii o,c,g i o,c,g i o,c,g i o,c,g

x X T y Y

3 3

i i i ii 1 i 1

E T (x ) (X ).

),,()()()(CGOOOOOOOPPPDPZPSxy

),,()()(CGOiiiiiPPPDPSxy

Leakage rates

Reduced oil demand at home reduces oil price and, thus, affects demand abroad for o (>0) and c, g (<0)

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Reduced oil production increases oil price and, thus, affects supply abroad of oil (>0) and of c,g (<0)

D

O

O

gcojOj

O

gcojj

S

OL

x

xY

x

XL

1,,,,

Ocgok

k

O

gcojj

D

OPD

y

YL

,,

,,

Global emissions effects

T = (i) gross (direct) effects + (ii) leakages through oil market + (iii) leakages through gas and coal markets

(iv) effects on domestic extraction emissions

(v) effects on foreign extraction emissions

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3 3

i i i ii 1 i 1

E T (x ) (X ).

  OPEC: Dominant producer OPEC: Competitive producer

Supply side Demand side Supply side Demand side

(i) Gross emission red 1 1 1 1

(ii) Oil market leakage -0.546 -0.454 -0.507 -0.493

(iii) Coal/gas market

leakage

-0.088 0.088 -0.096 0.096

(iv)Domestic extraction 0.028 0 0.028 0

(v) Foreign extraction -0.041 0.041 -0.043 0.043

Net emission red. 0.353 0.676 0.383 0.646

Table 1. 1 unit reduced oil extraction/consumption – net global emission reductions. Benchmark assumptions.

Benchmark:elDo

po=-0.5, elDgpo = elDc

po =0.1, elSopo =0.5, ´= 90/1000´= 300, ´opec =76

Marginal cost of forgone oil consumption for Norway•Climate Cure 2020: tasked to estimate costs of unilateral 2020 ambitions of the Parliament;•scenario with new demand side policies only in NETS (assumption: global contribution ambitions)

-20

0

20

40

60

80

100

120

0 2 4 6 8

million tonnes CO2

USD/t CO2

Marginal cost of forgone profits from Norwegian oil extraction•Data: Costs of cutting present production in several small, relatively costly fields in decline-phase•We assess: fairly representative for 2020

Leakage-adjusted domestic demand-side marginal abatement cost curve and the marginal supply-side abatement cost curve

0

100

200

300

400

500

600

700

800

900

0 1 2 3 4 5 6million tonnes CO2

USD/t CO2

marginal demand-sideabatement

marginal supply-sideabatement

Poly. (marginal demand-sideabatement)

Poly. (marginal supply-sideabatement)

• Combine the two and calculate their effects on global emissions when leakages are accounted for

• The domestic contribution target to global cuts is nearly 6 millt CO2• Demandside from left; supplyside from right.• Top of demand side: Only demandside (Klimakur)• Top of supply side: Only supply side (cheaper as in Hagem 1994)• Intercept: the cost effective combination:

Around two thirds of the measures to reduce global emissions should be supply side measures

Policy impacts: tax consumption and production:

• Demand side policies: Carbon tax rate: 248 USD/t CO2– Only oil demand cuts– 40% of the Climate Cure costs

• Supply side policies: Oil production tax: 53 USD/barrel(!)– App. half of the oil price– 3.4 percent of present domestic oil extraction– 50% tax could potentially lead to much larger cuts (if supply side is

cheaper than estimated)– Alternatives:

Only tax undeveloped fields More restrictive concession&exploration policies Less aggressive recovery ambitions in present fields

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Table 2. Sensitivity analysis. Effects of reducing Norwegian extraction or consumption of oil by one unit of carbon.

Net emission

reduction*

Target

( A )

Mt of

CO2

Supply- vs.

demand side

Optimal taxes

ixE

iyE Supply Demand Prod. tax

$/barrel

CO2 tax

$/ton

Benchmark case 0.353 0.676 5.7 66% 34% 53 243

Competitive OPEC 0.383 0.646 5.5 71% 28% 53 211

Fixed OPEC supply 0.49 0.539 4.6 87% 13% 45 119

Fixed oil price 0.005 1.025 8.7 0% 100% - 576

Supply two times more

elastic than demand

0.204 0.825 7.0 36% 64% 45 436

Demand two times more

elastic than supply

0.528 0.5 4.2 90% 10% 42 94

50% lower supply side

costs

0.353 0.676 5.7 84% 16% 29 131

* Net global emission reduction from reduced Norwegian oil extraction (supply side) or consumption (demand side) by one unit of carbon.

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ConclusionsConclusions

• Global emissions will most probably decrease when Norway cuts oil extraction

• Though many sources of uncertainty, robust conclusion: • The lion heart of the cuts should be implemented

through supply side policies • 2/3 in benchmark

• Rely on • Home country wishes to make unilateral actions• Offsets are not feasible or preferred alternatives• The objective is to cut global emissions

• Compared to the costs of demand policies only, costs are cut by 60%

Thank you for your attention

Discussion paper: Fæhn, T, C. Hagem, L. Lindholt, S. Mæland, and K.-E. Rosendahl

(2013):Climate policies in a fossil fuel producing country Demand versus supply side policies, Discussion papers 747, Statistics Norway

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